Orlando thinks that could be harbinger of things to come, as many wealthy investors have huge unrealized capital gains in technology stocks. These shares haven’t performed particularly well in recent weeks. However, most market observers chalk that up to a rotation to value in anticipation of an economic recovery and a rise in interest rates that has hurt a variety of long-duration assets, ranging from tech stocks to long-term bonds.
Could the reality of a whopping increase in the capital gains tax trigger a wave of tech stock selling? It’s possible. But Michael Cuggino, CEO and CIO of Permanent Portfolio Funds, thinks the reaction could be more nuanced.
One subset of investors might dump their shares, but another group could just opt to hold onto their winners and sit on their gains. Cuggino fears this would raise the cost of capital. That, in turn, could impair capital mobility.
Some would argue that, as a matter of social equity, leveling ordinary income and investment income tax rates as Reagan did in 1986 addresses the argument over preferential treatment of one group over another. As a resident of California, Cuggino is acutely aware that capital gains tax revenues from Silicon Valley have managed to save the Golden state’s bacon on many occasions, including the pandemic. Some would argue that it has also encouraged profligate fiscal behavior.
Higher taxes also have a downside for California, as evidenced by the decisions of a growing cadre of companies to leave the state. “The risk for California” is that “if you raise taxes you will get less revenue,” Cuggino said.
Bob Browne, chief investment officer at Northern Trust Asset Management, agreed that significantly higher taxes could pose a major risk that financial markets aren’t factoring to their prevalent rosy outlook. “It is possible that the Biden administration will be less market-friendly than the market thinks,” he said.
It is clear deficit spending can’t continue at the rate it has maintained over the last 12 months. One solution could be higher taxes. “It might be good social policy, it might [even] be good for the economy but not necessarily the market,” Browne said.
There are huge unrealized capital gains in many sectors of the equity universe besides technology shares, Browne observed. That’s one reason why he is urging clients to maintain their exposure to the high-flying sector even if they might want to make adjustments. One option could be to “take profits in Facebook and reinvest them in Microsoft,” he said.